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Following a recent decision of the Supreme Court (Carr v Gallaway Cook Allan1)it is more apparent than ever that parties need to exercise care when drafting agreements to arbitrate. The parties involved in the case had agreed to arbitrate a dispute between them, but had made an error in how they dealt with rights of appeal from the arbitration. As a result, the outcome of the parties’ lengthy (and consensual) arbitration process was invalidated.

Background

The case arose from a commercial transaction where Gallaway Cook Allan (GCA) had acted as solicitors for Mr Carr. Mr Carr then alleged that GCA had been professionally negligent. GCA and Mr Carr agreed to arbitrate that dispute with the arbitrator’s award to be final and binding on the parties. However, the finality of the award was subject to the qualification that either party had a right of appeal to the High Court on “questions of law and fact” followed by the words “emphasis added”. The problem with this appeal right is that the relevant statute (the Arbitration Act) provides for rights of appeal on questions of law only (not fact).

The parties conducted an arbitration before one of the country’s most eminent arbitrators, Hon Robert Fisher QC. Both parties participated fully in the arbitral proceedings and there was no issue raised as to the validity of the arbitration agreement and no suggestion that the arbitration had been conducted improperly. However, after the award was issued, the unsuccessful party (Mr Carr) argued that the award should be set aside because the agreement to arbitrate was invalid by providing for impermissible review on factual grounds. The High Court agreed and set aside the award. The Court of Appeal disagreed with the High Court and held that the ineffective words (“and fact”) should be severed from the rest of the agreement given that the parties had elected to resolve their dispute by arbitration, they had got what they bargained for, and the intent of the Arbitration Act was that parties ought to be bound to accept an arbitral award in these circumstances.

Supreme Court decision

On appeal the Supreme Court addressed three issues:

What constitutes an “arbitration agreement” for the purposes of the Arbitration Act?

Could the ineffective part of the arbitration agreement (allowing appeals on questions of fact)be severed so as to leave an otherwise valid agreement to arbitrate?

If the ineffective part could not be severed, should the arbitrator’s award be set aside under the Act?

Issue one – arbitration agreement

GCA, supported by the Arbitrators’ and Mediators’ Institute of New Zealand (who appeared as interveners), argued that the arbitration agreement was confined to the parties’ intention to submit the dispute to arbitration. Appeal rights were matters of arbitral procedure which were separate and did not affect that fundamental agreement to arbitrate (a position which has gained wide international acceptance). The Supreme Court disagreed and held that the parties’ agreement to arbitrate was made conditional on their agreed procedure which included a non-existent right of appeal.

Issue two - severance

The Supreme Court held that whether or not a contractual term could be severed is a matter of construction. Severance would not be permissible where it would destroy the central purpose of what the parties agreed or substantively alter the contract. In this case it was relevant among other things that: (i) the parties had italicised the words “questions of law and fact” and had further noted “emphasis added”; and (ii) the agreement to arbitrate was made in the context of determining GCA’s liability in negligence which was a “highly fact driven enquiry”. In these circumstances the Supreme Court held that the scope of the appeal right went to the “heart” of the parties’ agreement to arbitrate. Accordingly the words in issue could not be severed and the entire arbitration agreement was invalid.

Issue three - discretion

The majority of the Supreme Court (Elias CJ, McGrath, William Young and Glazebrook JJ) held that the lack of a valid arbitration agreement was so “fundamental a defect” that the High Court correctly exercised its discretion in setting aside the award.

Justice Arnold dissented on this issue. Justice Arnold held that the Court should refrain from exercising its discretion to set aside an award where the only defect is that the award followed a procedure contrary to a mandatory process. In other words, there ought to be a high threshold for a Court to refuse to enforce an arbitral award. That threshold will not be met where parties make mistakes in drafting arbitration procedure.

Conclusion

The case is generating a good deal of commentary with some of the view that it will have a negative impact on New Zealand’s reputation as an arbitration-friendly place to resolve disputes (i.e., a place where there is limited scope for interference from the courts and hence greater certainty about the finality and enforceability of any arbitral award). On the other hand, some see this as a reasonably fact specific result. That is, had the offending words not been in italics, and had there been no inclusion of the words “emphasis added”, the Court may have decided that the offending words could be severed and the arbitration agreement would otherwise have been enforceable. Putting aside the views of the various commentators, the case illustrates that parties contemplating arbitration must take care in drafting their agreements. For some more general tips on drafting alternative dispute resolution clauses please click here.